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Borrowers who can't make their mortgage payments may wonder why lenders are loathe to accept less in lieu of foreclosure.
The reasons can be found in a recent Congressional oversight panel report about the Treasury's Home Affordable Modification Program, or HAMP. The report focuses on HAMP, but much of the information is equally applicable to non-HAMP loan modifications.
The report explains why some modifications don't happen even though they appear to be "economically rational" on the basis of the net present value, or NPV, test, a statistical model that compares the expected financial outcome of the loan modification to the expected outcome of a foreclosure from the lender's (and investor's) point of view.
Here, according to the report, are some of the reasons, in brief:
- HAMP is a voluntary program. The government has cajoled servicers into participating, but has "little ability to pressure servicers when it comes to actually making modifications." Servicers haven't suffered any meaningful financial repercussions for their decision not to cooperate fully with the letter or spirit of the program.
- Accounting rules create a disincentive for modifications. If a loan is modified, the lender must immediately recognize the financial loss. If a loan isn't modified, the lender has more discretion to decide when to recognize the loss. Given the high redefault rate of HAMP loan modifications, lenders may prefer to keep nonperforming loans on the books rather than modify the terms and recognize the losses.
- In some cases, modifying a loan might change the lien priority when the borrower also has a second loan. The vast majority of HAMP modifications end up with a higher principal balance due to capitalization of missed payments and fees, but how courts would treat the effect of this principal increase on the priority of the loans isn't clear.
There's more -- a lot more, in fact. The report goes on to address "misaligned incentives" for loan servicers, pooling and servicing agreements, limitations of the NPV test, questionable sustainability of HAMP modifications, foreclosure processing problems, HAMP's failure to focus on the "root causes" of foreclosures, confusion about changes and enhancements to HAMP and a "flawed program structure."
That's a lot to digest, but it's certainly interesting reading.
